Archive for January, 2011

Day Trading: Knowing When to Exit a Losing Trade

I am guilty of it; you are guilty of it; the very best traders are guilty of it-sometimes it is very difficult to know when to fold.  There are a plethora of explanations to the irrational desire to hang on to a losing position in the misguided hope that your trade is going to make a dramatic turnaround.  It rarely happens, and most traders end up riding the trade too long and smashing into their stop loss.  The loss is always painful, and most of us (if we can be honest with ourselves) can usually identify a point in the trade where we should have exited with a minor loss.  Yet, we often fail to take advantage of this early exit and incur a substantial loss.

Why?

A great deal time and research have been spent on trading, especially the emotional and psychological aspects in trading decisions.  As a group, people have a strong need, and desire, to be right; and in the opposite sense, people have a strong aversion to being wrong.  Bailing out of a potentially disastrous trade is an admission that you, as a trader, have made a bad trading decision.  In short, you were wrong.  No one wants to be wrong. To be sure, I don’t want to be wrong.  Yet, as day traders there is usually a point in a trade were we would be well advised to admit we are wrong and save a bundle of money.  Most day traders seldom avail themselves of the early exit option.

When a trade is obviously going the wrong way it would seem obvious that a wise trader would be anxious to minimize his or her loses.  I have looked at some of my worst trades and been able to accurately pinpoint several exit points that were obvious.  Unfortunately, hindsight is 20/20.  Our emotions control much of our thinking in relation to trading, and once I (or any other trader) is convinced the trade is a good one it is no small task to change your mind quickly and accept that the trade is a terrible one.  As I said earlier, we like to be right; we dislike being wrong, and admitting we are wrong on the selection of a trade often leads to disastrous results.

Many texts and noted authors claim that leaving your emotions on the sideline is absolutely essential for successful trading. I don’t know about you, but my emotions are an integral part of my personality and the notion that I can carte blanch abandon them is wishful thinking, at best.  On the other hand, I do think we, as traders, can learn to minimize our emotions in the trade selection and trade management process.

What is the secret?  There is no secret; but developing the ability to see things as they are rather than as we hope is a skill to be developed.  The market is an emotionless, mechanical device and does not take your emotions into consideration in its day to day operations.  What we, as traders, think is completely irrelevant.  The skill that I work on constantly is seeing the market from a realistic point of view; not my point of view, but what is really going on in the market price action.  Reality can be a very painful teacher, especially when you are on the wrong side of a trade.  But it is reality that we have to work with, and traders must learn to trade from the perspective of what is really occurring in the market, not what we wish the market to do, or how we think the market should move.

In summary, I have noted that removing your emotions from trading is basically wishful thinking.  On the other hand, we can learn to develop a realistic view of how the market is moving and trade accordingly.  It’s no easy task, but with practice reality can become your primary viewpoint, not your wishes.


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